Significance of Ethereum ETPs Versus ETFs: Key Differences and Implications

Luisa
Crawford

Sep
16,
2024
16:07

Explore
the
critical
differences
between
Ethereum
ETPs
and
ETFs,
their
implications
for
the
crypto
industry,
and
the
broader
financial
market.

Following
the
listing
of
Bitcoin
exchange
traded
products
(ETPs)
earlier
this
year,
U.S.
stock
exchanges
made
available
ETPs
based
on
Ether,
the
asset
native
to
the
Ethereum
blockchain,
for
the
first
time
on
July
23.
Investors
can
now
buy,
sell,
and
invest
in
shares
of
products
that
hold
Ether
(ETH)
on
markets
such
as
NASDAQ
and
the
New
York
Stock
Exchange.
The
significance
of
this
development
cannot
be
overstated
—
not
just
what
it
means
for
Ethereum,
but
what
it
means
for
crypto
as
an
asset
class,
according
to

a16z
crypto.

ETH
ETP:
Why
it
matters
for
Ethereum

For
Ethereum,
the
ETP
approvals
settle
a
longstanding
question.
At
its
inception,
Ethereum
was
created
and
financed
by
a
combination
of
founders
and
investors.
The
prominent
role
of
these
creators
and
supporters
caused
some
to
question
that
the
original
distribution
of
Ether
formed
part
of
an
investment
contract,
thus
a
security
under
federal
law.
Over
time,
the
role
of
these
early
participants
diminished
and
the
development
of
the
Ethereum
blockchain
became
diffuse.
Today
it
rests
in
the
hands
of
its
user
community.

An
asset’s
status
as
a
security
or
a
non-security
affects
the
way
it
is
regulated.
Ether
being
a
non-security
makes
it
more
like
other
commodities,
like
oil,
that
have
no
central
owner
and
operator.
If
Ether
were
a
security
that
would
subject
it
and
transactions
in
ETH
to
a
panoply
of
compliance
and
ongoing
disclosure
requirements.
Worse
yet,
it
is
unclear
how
Ethereum
could
even
comply
with
those
rules
given
that
it
is
a
decentralized
open-source
project
with
many
contributors
and
no
single
party
in
control.
Those
impossible-to-meet
obligations
could
have
severely
jeopardized
the
promise
of
Ethereum
and
other
blockchain-based
technologies.

The
ETP
listings
indicate
that
the
SEC
has
reevaluated
the
status
of
Ether,
whatever
the
circumstances
around
its
launch
may
have
been.
It
seems
fair
to
conclude
that
the
SEC,
in
reaching
its
conclusion
on
ETH
ETPs,
applied
its
2019
framework,
which
sets
out
how
assets
involved
in
potential
securities
transactions
can
transition
to
become
non-securities.
Its
treatment
of
the
ETH
ETP
indicates
the
SEC
has
concluded
that
ETH
is
not
a
security
and
that
offers
and
sales
of
ETH
are
not
securities
transactions,
thereby
setting
an
example
for
others.

ETH
ETP:
Why
it
matters
for
the
crypto
industry

The
SEC’s
ETH
ETP
decisions
have
major
ramifications
that
extend
far
beyond
Ethereum.
After
significant
delay
and
regulatory
uncertainty
caused
by
the
SEC’s
ambiguity
and
silence
around
ETH,
the
new
ETPs
indicate
there
is
indeed
a
pathway
for
digital
assets
securities
to
transition
to
non-securities.
Importantly,
if
Ether
can
become
a
non-security,
so
can
other
digital
assets.
It’s
hard
to
imagine
a
more
consequential
precedent
to
set
for
the
crypto
industry.

Whether
the
SEC
wanted
to
hand
the
crypto
market
a
“win”
or
not,
it
has.
The
SEC’s
acknowledgment
underscores
the
dynamic
nature
of
crypto
and
the
importance
of
modernizing
securities
regulation
to
accommodate
crypto’s
integration
into
the
broader
system
of
commerce
and
financial
transactions.
Even
if
incidental,
regulatory
progress
is
underway.
The
regulatory
approval
of
the
ETP
listings
potentially
opens
significant
investor
access
to
crypto
assets,
unlocks
billions
of
dollars
in
value,
and
widens
the
universe
of
crypto
asset
investment.
And
indeed,
we
already
have
more
than
one
issuer
attempting
to
launch
ETPs
in
yet
another
crypto
asset,
Solana.
Expect
more
to
come.

ETP
basics

What
is
an
ETP?

ETPs,
or
exchange
traded
products,
are
typically
trusts
or
other
entities
that
hold
one
or
more
underlying
assets.
ETP
shares
trade
on
national
securities
exchanges
and
represent
interests
in
those
assets
held
by
the
trust.
The
shares
are
offered
pursuant
to
a
registration
statement
filed
with
the
SEC
and
effectively
track
the
value
of
the
assets
held
by
the
ETP.
If
you
hold
any
exchange-traded
baskets
of
commodities,
such
as
SPDR’s
popular
gold-tracking
product
GLD,
you’re
probably
using
an
ETP.

Why
use
an
ETP?

Traditionally,
ETPs
have
offered
numerous
advantages
over
holding
the
underlying
assets
directly,
such
as
improved
liquidity,
secure
and
convenient
custody,
best
execution
of
trades,
and
favorable
tax
implications,
including
potential
capital
gains
tax
advantages
due
to
the
buyers
and
sellers
electing
when
to
realize
taxes.
The
situation
is
more
complicated
for
crypto
assets,
as
discussed
later.

How
do
ETPs
work?

Typically,
ETP
shares
are
kept
aligned
through
arbitrage
and
a
process
of
creation
and
redemption:
When
the
public
ETP
trading
price
exceeds
the
value
of
the
underlying
assets,
ETP
shares
are
created
and
the
additional
supply
brings
the
price
down
to
align
with
the
asset
price
and
when
the
ETP
share
price
is
below
the
asset’s
market
price,
the
ETP
shares
can
be
redeemed
to
increase
the
ETP
share
value.
In
most
ETPs
this
is
done
by
a
group
of
“authorized
participants”
that
can
deliver
assets
or
shares
to
the
issuers,
depending
on
whether
a
creation
or
redemption
event
is
taking
place.

What’s
the
difference
between
an
ETP
and
ETF?

While
offers
of
ETPs,
exchange
traded
products,
and
ETFs,
exchange
traded
funds,
are
both
SEC
registered,
they
differ
significantly
in
terms
of
regulatory
requirements
and
structure.
ETFs
are
trusts
that
primarily
hold
securities,
ETPs
are
trusts
that
primarily
hold
non-securities.
As
a
result,
ETPs
are
registered
on
SEC
Form
S-1,
which
is
generally
used
for
offers
and
sales
of
securities
of
issuers
that
are
not
“investment
companies”
under
the
Investment
Company
Act
of
1940
(the
“40
Act”).
In
contrast,
ETFs
register
on
SEC
Form
N-1A,
a
form
specifically
designated
for
investment
companies.

Put
simply,
an
investment
company
is
an
entity
that
is:

• engaged
  in
  the
  business
  of
  investing,
  owning,
  holding,
  or
  trading
  in
  securities;
  and
• owns
  “investment
  securities”
  having
  a
  value
  exceeding
  40%
  of
  the
  value
  of
  the
  entity’s
  total
  assets
  (exclusive
  of
  U.S.
  government
  securities
  and
  cash
  items).

This
regulatory
difference
has
significance.
ETPs
are
treated
like
all
other
public
companies
and,
while
they
must
comply
with
the
reporting
and
other
requirements
of
the
Securities
and
Exchange
Act
of
1934,
they
are
not
subject
to
the
additional
layer
of
regulation
that
comes
with
being
a
registered
investment
company.
By
contrast,
ETFs,
because
they
are
in
the
business
of
investing
in
securities,
become
subject
to
the
‘40
Act,
and
must
comply
with
its
many
restrictions
on
liquidity,
affiliated
transactions
and
a
host
of
other
compliance
matters.

(In
practice,
some
entities
that
invest
in
commodities
or
pools
of
non-securities
can
opt
into
treatment
as
an
investment
company
by
placing
their
assets
in
a
subsidiary.
Because
they
now
own
securities,
i.e.
the
shares
of
its
subsidiary,
they
are
now
investing
in
securities
and
are
subject
to
the
‘40
Act.
Occasionally,
issuers
will
do
this
to
be
able
to
market
their
products
as
funds
subject
to
the
additional
protections
of
the
‘40
Act.)

Going
deeper:
Crypto
ETPs

Bitcoin
vs.
Ethereum:
What’s
in
a
BTC
ETP
vs.
ETH
ETP?

Bitcoin
and
Ether
are
two
of
the
most
prominent
digital
assets,
yet
they
serve
fundamentally
different
purposes.
BTC
is
primarily
a
unit
of
exchange
or
account
on
a
distributed
ledger,
functioning
as
a
decentralized
digital
currency.
Its
primary
utility
is
its
ability
to
facilitate
peer-to-peer
transactions
without
the
need
for
intermediaries.

By
contrast,
ETH
acts
as
a
unit
of
compute
within
a
global
virtual
computer
known
as
the
Ethereum
network.
This
network
supports
smart
contracts
and
decentralized
applications
(dApps),
enabling
a
wide
range
of
functionalities
beyond
value
transfer.
Consequently,
while
both
BTC
and
ETH
are
important
to
the
digital
asset
ecosystem,
their
differing
utilities
underscore
their
unique
roles
and
potential
applications.

What
are
the
advantages
of
ETH
ETPs?

For
crypto
assets,
some
of
the
traditional
advantages
of
ETPs
may
not
exist.
For
instance,
direct
holders
of
ETH
have
24×7
liquidity
in
crypto
markets
and
can
maintain
direct
control
of
the
asset.
Some
buyers,
particularly
buyers
new
to
crypto,
may
be
more
comfortable
with
owning
ETPs
than
owning
their
assets
in
wallets
or
crypto
custodial
arrangements.
Although
exchanges
on
which
ETP
shares
trade
are
often
deeper
than
markets
for
the
asset(s)
underlying
the
ETP,
it
remains
to
be
seen
whether
ETH
and
other
crypto-based
ETPs
will
enjoy
markets
of
comparable
or
better
depth
than
those
found
on
today’s
crypto
trading
platforms.
Additionally,
for
reasons
discussed
below,
the
ETP
shares
may
trade
at
a
discount
to
ETH
due
to
certain
operational
limitations
placed
on
the
ETPs.

Even
so,
ETP
products
for
ETH
can
expand
the
market
of
potential
buyers
and
sellers
of
ETH
to
fiduciaries
that
would
otherwise
be
precluded
due
to
myriad
reasons
including,
investment
restrictions
or
compliance
considerations.
Holding
assets
through
an
ETP
can
significantly
reduce
the
complications
associated
with
managing
and
safeguarding
assets.
For
example,
while
holding
crypto
can
be
technologically
complex
for
some
investors
and
consumers,
ETPs
provide
individuals
the
option
to
have
a
regulated
institution
manage
custody
for
them
while
investing
in
the
asset
class.

What
are
the
disadvantages
of
BTC
and
ETH
ETPs?

One
limitation
placed
on
the
ETH
and
BTC
ETPs
is
that,
unlike
most
other
ETP
products,
one
mechanism
by
which
the
trading
price
of
the
ETP
is
kept
in
line
with
the
market
value
of
the
underlying
asset
is
constrained.

Under
the
SEC
orders
for
ETH
ETPs,
buyers
cannot
bring
the
underlying
ETP
assets
to
the
trust
and
request
ETP
shares
in
exchange,
and
sellers
cannot
request
redemptions
of
ETP
shares
they
acquire
in
the
market
and
receive
underlying
assets.
Under
the
SEC
ETH
orders,
the
creation
and
redemption
of
ETP
shares
can
only
settle
for
cash.
Although
this
is
not
important
to
most
individual
investors,
this
limitation
on
institutions
maintaining
liquidity
when
there
are
buy
and
sell
excesses
in
the
arbitrage
process
may
subject
the
issuer
to
inefficiency
as
it
attempts
to
acquire
or
dispose
of
underlying
assets.
Given
the
volatility
in
crypto
prices,
this
extra
step
may
result
in
spreads
between
the
ETP
price
and
the
value
of
the
asset
that
it
is
designed
to
track.
This
unfortunate
limitation
may
lessen
the
attractiveness
of
the
ETP
product
as
a
way
to
gain
exposure
to
this
asset
class.

How
do
ETH
ETPs
deal
with
staking?

ETH
ETPs
have
another
quirk:
the
SEC
orders
approving
them
contain
a
prohibition
against
“staking,”
the
process
for
securing
the
blockchain,
which
in
return
dispenses
rewards.
This
is
a
right
that
direct
holders
of
the
asset
can
exercise.
ETH
ETP
owners
are
now
exposed
to
the
underlying
ETH
asset
but
precluded
from
earning
any
additional
ETH
through
staking
rewards.
This
prohibition
on
staking
may
complicate
the
arbitrage
process
described
above
and
could
be
considered
a
“bug”
of
holding
the
ETH
ETP,
rather
than
owning
ETH
directly,
depending
on
the
investors’
views.

On
the
one
hand,
eliminating
staking
could
be
considered
a
“feature”
as
it
simplifies
some
aspects
of
the
ETPs,
including
reducing
technical
complexity,
liquidity
constraints,
and
the
risk
of
slashing,
the
loss
of
ETH
due
to
computational
misconduct.
On
the
other
hand,
being
able
to
stake
ETH
that
is
directly
held,
can
provide
a
source
of
income
and
defray
carrying
costs
of
the
investment.
It
will
be
interesting
to
follow
the
pricing
implications
to
ETH
ETPs
of
the
prohibition
on
staking
ETP-held
ETH.
If
the
foregone
income
is
reflected
in
a
discount
in
the
pricing
of
ETP
units,
some
investors
may
prefer
holding
ETH
ETPs
to
holding
ETH
directly.
In
other
words
they
may
find
the
discount
more
attractive
than
the
potential
staking
returns
which,
as
described
above,
come
with
some
complications.

A
second-order
effect
of
the
staking
prohibition
is
that
it
could
cause
network
security
issues
to
the
extent
that
an
outsized
portion
of
all
ETH
is
locked
in
the
ETP
and
prohibited
from
staking.
Although
unlikely,
this
would
result
in
a
smaller
(relatively
speaking)
set
of
holders
of
ETH
that
validate
transactions
in
ETH
and
could
provide
that
group
disproportionate
influence.

What’s
more
advantageous:
ETH
ETPs
or
directly
holding
ETH?

Investors
can
weigh
the
convenience
and
accessibility
of
holding
ETPs
against
the
benefits
of
direct
ownership.
While
the
ETP
can
offer
some
ease
of
trading
and
storage
advantages,
direct
ownership
provides
greater
control,
participation
rights,
and
the
ability
to
stake
ETH.

Ultimately,
the
approval
of
ETH
ETPs
provides
investors
with
an
additional
method
to
acquire
exposure
to
ETH.
Which
alternative
they
choose
will
depend
on
each
of
their
own
assessments
of
the
factors
outlined
above
and
whether
they
intend
to
use
ETH
for
its
computational
purposes.
Regardless
of
their
choice,
having
options,
particularly
an
option
that
recognizes
that
decentralized
digital
assets
such
as
ETH,
are
non-securities,
is
a
very
positive
development.

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source:
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